All theses

S&P Global

"In November 2020 S&P announced a merger with IHS Markit. While we have a positive informed opinion about this combination, the market did not react favorably."

The S&P Global stock has been part of our portfolios for some time now. In November 2020 S&P announced a merger with IHS Markit. While we have a positive informed opinion about this combination, the market did not react favorably. We increased our position. Today presents an interesting moment in time to share with you our views on the company and the outlook for the stock.

S&P Global is a conglomerate with various activities in financial services. The company is best known as a rating agency, where it acts in a duopoly with Moody’s. S&P Global is also well known as an index provider, lending its name to e.g. the S&P500 index. S&P Global is also the owner of CapitalIQ, a software application that distributes data to the finance sector as one of the only competitors of Bloomberg. Finally, S&P Global owns Platts, a provider of pricing data for several commodities. If for example a steel manufacturer in China signs a contract for delivery with an iron ore mining company in Australia, the agreed price will be linked to data from Platts.

All four activities enjoy very little competition which lends strong pricing power to the company. And each of the business lines have excellent growth outlooks.

Let us look closer at S&P as a rating agency and as an index provider. If a company wants to raise capital by issuing a bond, the market expects this bond to have been rated for risks. The grade of the rating is often a condition of investment eligibility for many investors. At Laaken for instance, we are committed to a policy of always investing a minimum percentage of our fixed income allocation in bonds with a single-A credit or higher. If a company chooses not to have its debt securities rated at all, interest owed on these loans will typically be 0.3% higher than on similar bonds rated by S&P. With such an unwelcome interest premium in mind, most issuers will choose to make the required one off payment to S&P of 0.09% plus an annual observation fee to obtain and keep a rating.

As the owner of the S&P500 index, S&P profits from S&P futures trading, or when investors buy S&P500 ETFs. The rapidly increasing popularity of ETFs and the market shift towards passive investing has resulted in strong growth of this business. Because most ETFs are issued by mega-asset managers such as Blackrock or Vanguard the average compensation to the index provider per dollar invested is steadily declining. However, this decline in unit fees is more than offset by the strong growth of total capital inflow in these instruments.

Going forward, both the rating business and the index business have strong potential for growth in environmental, social and governance (ESG) products. Market trends and regulations are moving towards more ESG accountability. We expect future bonds to not only have a risk rating, but also an ESG or ‘green’ rating. Basically, the greener the bond, the lower the interest rate will be. We further expect an increase in demand for ESG funds. S&P Global, with its strong brand name and the enormous amount of data they have collected from their clients, is well positioned to play a major role in benchmarking to which extent a company complies with ESG criteria that investors set.

The announcement of the merger with IHS Markit came as a surprise and is one of the largest mergers of the year. S&P Global boasts an 80 billion USD market cap, IHS is listed at 40 billion USD. Much like S&P Global, IHS Markit is a conglomerate with a data driven product offering. On the one hand, IHS Markit owns financial data, mostly pricing data for illiquid bonds and derivatives. On the other hand, the company has a very diverse offering of industrial data, aimed amongst others at the automotive, shipping and energy industries. A car manufacturer will always consult IHS Markit data before it starts development of a new model. Governments pay IHS Markit to know which vessels sail their seas and if these comply with their environmental requirements. An oil refinery will consult IHS Markit before they decide to expand. And much like the activities of S&P, IHS competition is very limited.

Apart from potential cost synergies, interesting new business opportunities arise. For example, IHS Markit offers bond indices, which in combination with S&P’s equities indices could produce new, multi-asset indices. The value of the industrial data owned by IHS will increase if it is added to CapitalIQ, finding its way to a larger group of end users. And to conclude, the demand for ESG products mentioned earlier is still in an early stage. Many of the product offerings have yet to be developed. By combining the data sets from both companies at this early stage and by avoiding duplicative research and work, S&P Global can strengthen its perspective to become the market leader.

Combined turnover is expected to grow 6 to 8% per annum. With profit margins increasing significantly, total growth is expected to reach 10% per year. Nevertheless, the combination trades at 30 times 2020 earnings, or 25 times 2023 earnings; a lot lower than other companies with similar growth forecasts. The balance sheet is virtually debt free. And because the business is not capital intensive, the annual 3 to 4% earnings yield is not needed to achieve the mentioned 10% growth and can be distributed to investors. The expected return amply meets the requirements that we set for these investments.

To support our investment case, we like to look what the insiders do with their investments. Lance Uggla, founder and CEO of IHS Markit, holds approximately 110 million USD of his own capital in IHS stock. He merged IHS with S&P against only a 5% premium above market price when he could have gotten a 30% control premium if he had played the deal out with other potential buyers. His 110 USD million stake in IHS has now changed to a ~115 million USD stake in S&P Global. Apparently, Mr Uggla is confident of the potential synergies and chose not to seek the highest bidder.

More theses

Broadridge

Broadridge delivers mission critical services that are deeply integrated in the workflows of banks and brokers. Despite its indispensable role, Broadridge’s services represent only a small part of their customers’ cost structure. This combination translates into an attractive business model. Broadridge is a recent addition to our portfolios. We will explain our investment rationale below.

Rentokil Initial

Rentokil Initial (RTO) provides pest control and hygiene services worldwide. RTO merged with Terminix, a US competitor, in December 2021. RTO expects the transaction to close in Q3 2022. Following this transaction, RTO will become the largest pest control company in the world with 26% market share in the United States, representing more than half of the global market.

McKesson

Founded in 1828, McKesson (MCK) is one of the three major drug distributors in the United States, along with AmerisourceBergen and Cardinal Health. They distribute medicines from manufacturers to pharmacies. This industry is characterized by significant entry barriers such as high requirements from the Food and Drug Administration (FDA). MCK shows limited cyclical sensitivity with stable sales even during the financial crisis in 2008/2009. MCK earns a percentage of the value it distributes from generic drugs and a fixed value per unit from branded drugs.

IQVIA

A merger between Quintiles and IMS in 2016 resulted in IQVIA. We evaluated the merger as a positive development and became shareholders in 2018.

ASML

ASML was founded in 1984 as a joint venture between ASM International and Philips. The company spun off in 1988 and has since developed into one of the world’s leading suppliers to the chip industry. In our investment thesis we share why this company is included in the portfolio.

Novo Nordisk

Novo Nordisk (NVO) has been part of our portfolios since 2009. The company is the world leading producer of insulin medication. NVO has been led by Lars Jorgensen and since his appointment in 2017 the shares have achieved a return of 20% per year.